Before getting into the practical details of the common misconception about investments, let us start by understanding what an investment is. An investment is an asset or item acquired with the goal of generating income or appreciation. Investments involve the purchase of goods that are not consumed today but are used in the future to create wealth.
It also involves purchasing an asset with the intention that in the near future, the assets will generate income or be sold for a higher price. Investments however, should not be confused with savings, which is keeping money for emergencies in a fund without the intention of generating wealth. The major differences between investments and saving is the risk involved and the return generated.
In investments, investors take risk by investing in particular investments assets that have a possibility of making losses while in savings, no risk is taken as the money is placed in a safe storage until maturity.
In most cases, most people do not start their investment journey due to the various misconceptions around investments. These misconceptions often pose a threat to one reaching their investment goals.
Have you ever thought of investing and you did not due to the myths and misconceptions around it? Ann Wacera of Cytonn Investments (pictured) helps demystify some of the common misconceptions about Investment.
1. You need a lot of money to start investing
This is a common misconception that has deterred people from investing. In essence, you do not need a lot of money to start investing. Warren Buffett, one of the most successful entrepreneurs is believed to have started his investments career with a stock that cost USD38 per share, equivalent to approximately Sh4,000 currently.
In the current market, one can invest in the equities market either directly on their own or via Collective Investment Schemes such as Equity Funds (which buy ownership in businesses most often in the form of publicly traded common stock), with as little as Sh1,000 or invest in government papers using Collective Investment Schemes such as Money Market Funds with as little as Sh100 in select Money Market Funds.
2. Investment assets with the highest risk will always generate the highest returns
Albeit this might true, it is not always the scenario. Investing is stocks for instance is risky and they usually generate higher returns compared to other investments such as bonds. However, when the stock underperforms, so does the return on the investment.
3. Large-cap stocks are the safest stocks
The previous performance of a stock does not indicate that the stock will continue to perform well in the future or generate good returns. Rather than focusing on previous performance of a stock, investors should look at the companies’ price to earnings ratio - This will help you know how much you stand to gain for every share you purchase. How often they pay out dividends and their dividend payout ratio (this is a percentage of the profits made by the company).
4. Wait until you are sure
This misconception is mainly applicable in the equities market. Given the outbreak of the Coronavirus pandemic, most stocks have been on a downward trend with most trading at cheaper valuations.
When a stock is trading in a bear market or the stock is experiencing price corrections, most investors take a ‘wait and see’ approach. The idea that a stock should behave in a normal way and clearly indicate when it is the right time to invest, is a myth.
The equities market is normally volatile and instead of taking a ‘wait and see’ approach, buy stocks at every price dip. Should the price recover, you will make high profits when you sell it a higher price.
5. You can only start investing when you know all there is to know about investments
While there exists a broad range of investment asset classes that are complex, there are a number of investments options that are easy to understand. It is advisable to start with an investment option that is easy to understand such as Money Market Funds, the stock market etc. With the resources available on the internet, one can build their knowledge on matters Investments. You can also speak to a Financial Advisor who will help you in your journey.
In conclusion, misconceptions can be costly and will ultimately lead to one not reaching their financial goals. It is important for one to familiarize themselves with the fundamentals of investing before starting their investments journey. Laying down their investment goals and objectives will be essential in understanding the investments approach they should take.
Dr Pesa is Ann Wacera who is part of the Investments team at Cytonn Investments.